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In its recent decision in Valley Bank and Trust Company v. Spectrum Scan, LLC (In re Tracy Broadcasting Corp.), the U.S. Court of Appeals for the 10th Circuit overturned lower court decisions that were casting serious doubt on a lender’s ability to realize value from its security interest in the proceeds of FCC broadcast licenses. This alert will briefly describe the law governing security interests in FCC broadcast licenses, as well as the issues created by the lower courts – and ultimately resolved by the appeals court - in the Tracy case.

The Federal Communications Commission (FCC), created by the Federal Communications Act of 1934 (FCA), is the sole source of licenses for the use of radio channels. The FCA is clear that the owner of such a license may not transfer, assign or dispose of the license in any manner without the consent of the FCC, thus effectively prohibiting the grant of security interests under Article 9 of the Uniform Commercial Code (UCC) by licensees of FCC broadcast licenses.

For many years, however, the FCC has indicated its approval of security interests in the proceeds of FCC broadcast licenses. A lender’s remedies against such collateral are obviously limited (e.g., the lender must wait to realize value on its collateral until an FCC-approved sale of the license by the licensee), but lenders have become comfortable with these limitations and underwrite their loans accordingly.

In the Tracy case, a lender made a pre-petition loan to the debtor, an FM radio station operator, secured by, among other property, the borrower’s general intangibles (the definition of which in the UCC would include FCC licenses) and proceeds. After the debtor’s bankruptcy filing, the issue was not whether the lender had a security interest in the debtor’s FCC license – clearly it did not due the prohibition discussed above. Rather, the issue was whether the lender had a security interest in the proceeds of the license as a result of section 552 of the Bankruptcy Code.

Section 552 of the Bankruptcy Code implements a concept well-known to secured lenders – property acquired by a bankrupt debtor is not subject to a pre-petition security interest. With an eye on Section 552, a pre-petition judgment creditor in Tracy argued that the proceeds of an FCC license do not exist until such proceeds actually arise or are no longer speculative (such as when a contract for the sale of the license has been signed). Since no such contract existed or was even contemplated at the time of Tracy’s bankruptcy, argued the judgment creditor, Section 552 prevents the lender’s pre-petition security interest from attaching to the license proceeds that would arise, if at all, only post-petition. The Colorado bankruptcy court agreed, and the Federal district court in Colorado affirmed the bankruptcy court’s holding in a decision handed down in September, 2011.

These lower court rulings were quite unwelcome by broadcasters and the financial institutions that make loans to broadcasters secured by the proceeds of FCC licenses. After all, if a lender’s security interest in such proceeds effectively can be cut off by a bankruptcy filing, there is little to no value in such a security interest, which in turn could result in restricted access to and higher cost of debt capital for broadcasters.

To the great relief of many, the 10th Circuit Court of Appeals stepped in to reverse the lower court rulings in a decision handed down on October 16th of this year. The 10th Circuit essentially held that the proceeds of FCC licenses do not have to exist at the time a security interest in them is granted (or at any other time prior to the licensee’s bankruptcy filing) to be subject to a pre-petition security interest that cannot then be cut off by Section 552 of the Bankruptcy Code.

Based on the 10th Circuit’s ruling in Tracy and a similar ruling in 2011 by the prominent Southern District of New York bankruptcy court in the case of Sprint Nextel Corp. v. U.S. Bank Nat’l Ass’n (In re Terrestar Networks, Inc.), strong arguments exist for the wide-spread application of the court’s reasoning in Tracy. However, since no courts outside of the 10th Circuit are required to follow Tracy, lenders with security interests in the proceeds of FCC licenses - or that contemplate taking such security interests - should continue to monitor this line of cases for possibly different outcomes in other parts of the country.